Yes! With the right annuity plan and when you take on financing, we can achieve higher than 7% annualized return.
People familiar with the insurance industry in Singapore are usually aware that insurance companies here adopt a more conservative approach to investing their participating funds. Participating products in the market (i.e. your annuity or endowment plans or whole life plans), though are highly stable and consistent in distributing projected bonuses, generally do not give us high returns.
As a reference, the long term annualized returns of Singapore dollar annuity plans normally range from 3.5% to 4%. Even products with the highest projected returns hardly ever go above 4.5%.
Still, there are a number of financial tools available in Singapore that can help us significantly enhance the actual return we can get from participating plans, the most common of which is "premium financing".
What is "Premium Financing"?
Simply put, "premium financing" means instead of you paying the full premium of an insurance plan solely out of your own pocket, now you get a loan from a bank to pay for a (large) part of the total premium. The remainer is still borne by yourself.
In return, you need to repay the bank the loan interest every month. You also agree to use the insurance policy you bought as a loan collateral, until your loan is fully paid off. In fact, it is very similar to how we borrow money from banks to buy cars and properties.
There are 2 things especially worth noting about "premium financing".
No 1. "Premium financing" can only be applied for single-premium life insurance policies that have cash value from Day 1. Examples of such products include single-premium annuity plans, single-premium whole life plans, and Universal Life plans.
The Day 1 cash value of such policies are usually at 80% of the single premium. Banks can then offer a loan of up to 90% of this Day 1 cash value. In other words, we can borrow up to 72% (80% x 90%) of the single premium from the bank, and we only need to bear the remaining 28%.
No 2. Loans from premium financing can be repaid in two ways. The first way is to repay interest plus pricipal, which is similar to how we repay house mortgages.
The second way is to repay interest only and is more often adopted in premium financing. The loan principal is only repaid when the policy matures, the life insured dies, or the policy is surrendered. Only in these events, the bank will receive the total payout from insurance company, settle the loan, and return any remaining balance of the proceeds to the client or client's designated beneficiary(s)
How does "Premium Financing" Amplify an Annuity Plan's return?
The key to achieving higher return with "premium financing" is that the return we generate from the loan amount is higher than the cost of borrowing, that is, the loan interest.
We take Signature Income (II), an annuity plan from M company to illustrate.
Assuming a 40-year-old male client is buying a Signature Income (II) plan with a single premium of $250k. He wishes to start receiving policy payouts from the 4th year onwards. Based on the system-generated policy illustration, the client can expect a yearly income of $10,380 till the age of 120 or death. Upon full surrender, policy maturation or death, the client will receive another lump sum payout.
The following tables illustrate the death benefit and surrender value at different ages or policy years.
Death benefit. If client dies at age 90, he can expect a lump sum payout of $267,608 based on 4.75% investment return.
Surrender value. If client surrenders the policy in year 20, he can expect a lump sum payout of $232,614 based on 4.75% investment return.
Scenario 1: No "premium financing"
We can input the cash flow into an Excel sheet and use the IRR formula function to calculate the annualized return.
(1) Assuming client surrenders the policy at the end of 20th policy year
The surrender value received is $232,614. The total cash inflow in this year is $242,994 (= $232,614 + $10,380). An IRR calculation gives us an annualized return of 3.10%.
(2) Assuming client dies at age 90
The death payout is $267,608. The total cash inflow in this year is $277,988 (= $267,608 + $10,380). An IRR calculation gives us an annualized return of 3.69%.
Scenario 2: With "premium financing"
One of the banks that offers premium financing gives a Singapore dollar financing rate of SIBOR + 1.0%. The current 1-month-SIBOR rate is 0.26500% and the current 3-month-SIBOR rate is 0.43750%. Let's assume SIBOR rate stays at 0.5%, so the annual loan interest would be 1.5%.
The loan amount limit for a $250k single-premium annuity plan is $180k, reducing client's initial cash outlay to only $70k. The interest that client needs to repay the bank every year is $2,700 (= $180k × 1.5%). From the 4th policy year onwards, we start to receive annual payouts of $10,380. Hence, the net cash inflow from 4th year onwards becomes $7,680 (= $10,380 - $2,700).
(1) Assuming client surrenders the policy at the end of 20th policy year
The surrender value received is $232,614. The total cash inflow in this year is $242,994 (= $232,614 + $10,380). The total cash outflow this year is $182,700 ( = $2,700 + $180000), as client needs to repay the principal upon surrender. Despite paying the interest and principle, an IRR calculation now gives us an annualized return of 6.73%.
(2) Assuming client dies at age 90
The death payout is $107,043. The total cash inflow in this year is $277,988 (= $267,608 + $10,380). The total cash outflow this year is $182,700 (= $2,700 + $180,000). Now, an IRR calculation gives us an annualized return as high as 7.92%!
Summary
The returns in the illustrations above can be summarized into the table below:
Annualized returns of Signature Income (II) SGD in different scenarios
As can be seen, an annualized return of above 7% is actually quite achievable with the help of premium financing.
However, we must bear in mind that the illustrations rest on a critical assumption that the SIBOR rate, hence the cost of borrowing, remain as low. If we look at the SIBOR Rate Historical Chart, while the SIBOR rate stays below 1% majority of the time, it does shoot up to 2% or even a very high 3.5% in rare circumstances.
Data obtained from MoneySmart.sg
What if (thoughly unlikely) SIBOR goes up significantly again and stays around a high 2% in the long term? In this case, the cost of borrowing Singapore dollar will become 3% (SIBOR + 1%). Instead of repaying an amount of $2,700 per year for the loan interest, client now needs to pay $5,400 (Loan amount of $180,000 × 3%) every year.
Using the same method to calculate, we get an annualized return of 5.02%, if client passes on at age 90.
As can be seen, despite assuming a very high SIBOR of 2% on average, the return we are able to derive from the plan still beats most other annuity plans in the market by a significant margin.
If you wish to know more about "premium financing" or annuity plans that ride on this benefit, feel free to drop us a message here or on our Facebook page "SG Life Insurance". Our experienced consultants will reach out to you the soonest :)
What if the interest stays at 5.4k but insurer reduce the bonus to 3.25%? What would be the nett payout?
ReplyDeleteHi Bluesotong, sorry for late reply. If interest stays at 5.4k per year and insurer distributes based on 3.25% illustration, then the nett payout per year will be reduced to $1,011. This is unlikely to happen though, because historical stats show that insurers in SG have been distributing pretty consistently based on 4.75% illustration. Hope this clarifies :)
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